Stock Options and Chief Executive Officer Compensation

Operations Research, Vol. 58, No. 4, Part 2 of 2, July–August 2010, pp. 1090–1106

Rock Center for Corporate Governance Working Paper No. 27

48 Pages Posted: 21 May 2007 Last revised: 6 Nov 2012

See all articles by Chris Armstrong

Chris Armstrong

University of Pennsylvania - Accounting Department

David F. Larcker

Stanford University - Graduate School of Business

Che-Lin Su

University of Chicago - Booth School of Business

Date Written: May 15, 2007

Abstract

Although stock options are commonly observed in chief executive officer (CEO) compensation contracts, there is theoretical controversy about whether stock options are part of the optimal contract. Using a sample of Fortune 500 companies, we solve an agency model calibrated to the company-specific data and we find that stock options are almost always part of the optimal contract. This result is robust to alternative assumptions about the level of CEO risk-aversion and the disutility associated with their effort. In a supplementary analysis, we solve for the optimal contract when there are no restrictions on the contract space. We find that the optimal contract (which is characterized as a state-contingent payoff to the CEO) typically has option-like features over the most probable range of outcomes.

Paper published as: "Endogenous Selection and Moral Hazard in Compensation Contracts" in Operations Research, Linthicum 58 (July/August 2010): 1090-1106.

Keywords: Stock Options, Incentives, Agency Model

JEL Classification: C61, D82, D86, J33, J41

Suggested Citation

Armstrong, Chris S. and Larcker, David F. and Su, Che-Lin, Stock Options and Chief Executive Officer Compensation (May 15, 2007). Operations Research, Vol. 58, No. 4, Part 2 of 2, July–August 2010, pp. 1090–1106; Rock Center for Corporate Governance Working Paper No. 27. Available at SSRN: https://ssrn.com/abstract=987693 or http://dx.doi.org/10.2139/ssrn.987693

Chris S. Armstrong

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

David F. Larcker (Contact Author)

Stanford University - Graduate School of Business ( email )

Graduate School of Business
518 Memorial Way
Stanford, CA 94305-5015
United States
650-725-6159 (Phone)

Che-Lin Su

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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